Tax Exempt Changes
(from Maine Townsman, December 1999)
by Geoffrey Herman, Director of State & Federal Relations, MMA

State law has long required the Taxation Committee to conduct a review of the laws governing property tax exemptions at least once every four years and submit a report on its findings to the full Legislature, along with any recommended changes. The last such review and report was accomplished 12 years ago.

The present Taxation Committee was bound and determined not to shirk its responsibility. Since late August, the tax panel has been meeting every other Wednesday in order to analyze information and deliberate over the policy issues that are central to the debate over property tax exemption.

For example, if a tax exemption is the equivalent of a tax expenditure, which taxpayers should pay for the exemption that is given to hospitals, nursing homes, colleges, social service agencies and the state facilities that provide services to people over large regions and throughout the state? And if it is a given that charitable organizations are exempt from paying any property taxes whatsoever, should there be any standards of eligibility for that privilege beyond the corporation organizing itself financially as a non-profit for a stated charitable purpose?

ACCOUNTABILITY TO TAXPAYERS

At the heart of these questions is the matter of accountability to the taxpaying public. There is approximately three billion dollars worth of non-governmental exempt property in Maine, the bulk of which is owned by charitable organizations, literary and scientific institutions, churches and industrial corporations. With respect to the charitable organizations, there are no standards of eligibility beyond organizing as a non-profit organization and claiming a charitable purpose. The municipalities that support those organizations with free services are asking for standards which could lend some accountability to this exemption which the Legislature creates but doesn’t pay for.

This drive for standards is not unlike the Legislature’s own efforts to infuse a greater level of accountability with respect to the tax breaks and business incentive programs the Legislature provides and pays for, such as the Business Equipment Tax Rebate (BETR) program. In 1998, the Legislature created the Economic Development Incentive Commission and charged it with determining the returns to Maine’s taxpayers that are obtained through the various financial incentives the government gives to businesses. Whether the focus is on business incentives or property tax exemptions, the motive for accountability is the same. The taxpaying public deserves to be confident that its tax expenditures to private corporations are warranted.

As a result of its many Wednesday conventions, it now appears that the Taxation Committee will be submitting a report to the full Legislature in January that will recommend important changes to the tax code as well as a financial mechanism designed to relieve the local property taxpayers of some of the burden of supporting the tax exempt facilities that serve large regions and the state as a whole. The Committee’s final review of its package of recommendations is scheduled for December 15 (see box on page 17 for a discussion of the Committee’s December 15th meeting). What follows is a description of the recommendations that have been developed by the Committee, subject to one final review.

Proposed Changes to the Tax Code

The Committee’s report to the Legislature, in draft form, recommends four substantive changes to the law governing property tax exemptions, all of which are focused on the exemption for "benevolent and charitable" organizations. In addition, the Committee will recommend the formation of a working group to look into the several problematic aspects of the law governing the pollution control equipment exemption.

The 501(c)(3) parallel. One new standard of eligibility the Tax Committee is recommending is that a charitable organization must qualify for the federal income tax exemption under Section 501(c)(3) of the IRS Code. For municipalities, this new standard adds little to any meaningful determination of an organization’s "charitability" because the federal standards of eligibility are no more evaluative of an organization’s actual charitable performance than the current shallow standards in effect in Maine; that is, the organization needs only be financially organized as a non-profit corporation and providing a generically charitable purpose. It should also be noted that this recommended new standard would not require 501(c)(3) status as a threshold standard of eligibility. It would only require the organization to qualify for 501(c)(3) status. If an organization applies for a property tax exemption but has not applied to the IRS for 501(c)(3) status, it would be up to the municipal assessor to determine if the organization would qualify under the federal rules. As improbable as that sounds, the purpose of the flexible standard is to allow small charitable organizations with very little in the way of financial resources to obtain their property tax exemption, with the approval of the local assessor, without necessarily posting the $150 application fee to the IRS and undergoing the substantial paperwork process.

Actual and Regular Use. As will be discussed in more detail below, Pennsylvania is far ahead of most states when it comes to clear and comprehensive standards of eligibility for the charitable property tax exemption. The exceptional quality of Pennsylvania’s law on charitable exemptions begins in the state’s Constitution, which limits all exemptions for the "purely public charities" to "only the portion of real property…which is actually and regularly used for the purposes of the institution." Many states apply a similar standard as a matter of law (Iowa, Tennessee, Missouri, South Dakota, Maryland and Kansas, to name a few), and many other states employ the standard as a matter of regulation or practice.
Unlike these other states, Maine has never adopted the "actual and regular use" standard. In the absence of this standard, Maine’s courts have repeatedly found that property owned by an exempt institution that is in marginal, limited, incidental, or irregular use is nonetheless completely exempt from taxation.

The Taxation Committee’s recommendation would install the "actual and regular use" standard into Maine law. If ultimately adopted by the Legislature, this standard would allow the municipal assessor to identify the portions of any property owned by an exempt organization that are actually and regularly used to support the organization’s charitable purpose as well as those portions that are not being put to a regular and actual use. The unused portions of the property would be taxable.

To understand the application of the "actual and regular use" standard, it might be helpful to look at the applicable antonyms. The opposite meaning of "actual use" is either non-use or potential use. The opposite meaning of "regular use" is a minimal, marginal or sporadic use. To exemplify the need for some standard, there are several decisions of Maine’s Supreme Court which have held that tracts of essentially unused property are exempt from taxation merely on the basis of their potential value to the organization. Other decisions have allowed for the continued exemption of property where the functional use of the property had ceased or whatever remnant use of the property that existed was sporadic, irregular and only marginally related to the purpose of the organization. An "actual and regular use" standard clearly adds a measure of accountability to current law.

Real estate rented by hospitals. The general rule governing all exemptions is that the property that is leased by the exempt entity (but belongs to a non-exempt owner) is taxable. That general rule exists because otherwise the property tax break would be enjoyed by individuals, businesses and corporations that are not engaging in any charitable activity.

In all Maine law, there are only two exceptions to this general rule. Schools don’t have to pay a property tax for the portable classrooms they lease, and any real estate or personal property that is leased by a hospital, health maintenance organization or a blood bank is exempt from taxation.

The Taxation Committee was willing to accept the exemption of personal property leased by hospitals to businesses. The most commonly used example to support the propriety of the leased-personalty exemption is the expensive MRI machine that is more effectively owned and maintained by a separate, specializing company than by the hospital itself.

On the other hand, the Committee is recommending an end to the special exemption for leased real estate. Real estate is not a specialty product that is bought, sold or leased on a special market. When the law allows one class of tenant to effectively create a property tax exemption for the landlord, an uneven playing field has been created in the market. In this case, an instability in the municipality’s taxable real estate base has been created as well. It is probably impossible to determine who makes out best – the hospital or the landlord – as a result of the special hospital exemption for leased real estate. It is another one of those accountability questions. It’s easy to determine the group of folks who make out worst, however — the remaining taxpayers in the community that hosts the hospital.

The gratuitous donation of a substantial portion of services. As mentioned above, Pennsylvania has developed the most clearly articulated public policy on property tax exemptions in the nation. In addition to the ubiquitous IRS-type standards (being a non-profit institution organized for a "charitable purpose"), and in addition to the "regular and actual use" standard described above, the Keystone State employs three additional standards of eligibility that organizations must meet in order to be forgiven their property tax obligation.

• The organization must donate or render gratuitously a substantial portion of its services;

• The organization must benefit a substantial and indefinite class of persons who are legitimate subjects of charity; and

• The organization must relieve the government of some of its burden.

In addition to these overarching standards, Pennsylvania law lays out the specific qualifying standards that assessors can use to measure whether the organization passes these tests.

Maine’s Taxation Committee was unwilling to adopt the comprehensive Pennsylvania model wholesale. On the other hand, there was one important component of the Pennsylvania approach that did make sense to the Committee, and that is the requirement that a charitable organization must "donate or render gratuitously a substantial portion of its services." A gratuitous giving , which is a giving without any expectation of return, is what charity is all about. And even though a majority of corporations today – both for-profit and not-for-profit — probably donate free services to some degree, it only makes sense that a true charity must donate a substantial portion of its services gratuitously in order to be forgiven its property tax obligation.

The element of this new overarching standard that the Committee was unable to develop, however, is how to measure a "substantial portion". The Pennsylvania standards employ a number of alternative mathematical approaches that analyze the value of the uncompensated goods and services relative to the organization’s total operating expenses, net operating income, or other similar reference point. In fact, the Pennsylvania standards are crafted to recognize the different ways charitable organizations provide services to the beneficiaries and accommodate both the organization that deeply subsidizes a few of its clients and the organization that provides a more modest subsidy to a broader client base.

Maine’s Tax Committee was unwilling to craft such a seemingly complicated analysis into law, and Maine Revenue Services was similarly disinclined to undertake the development of those standards by rule. Along with the overarching "substantial gratuitous portion" standard, the Committee’s recommended changes to statute will include an express authority for the local assessor to obtain from a charitable organization a written "estimate of the value of uncompensated goods and services provided by the institution", and as the analytical methods to extract that data come into common use, the municipalities should begin to gain a better understanding about the true value of the services being provided "gratutiously".

It’s another step toward accountability.

Pollution Control Equipment

There are two municipal issues with respect to the pollution control equipment exemption found at 36 MRSA 656, which is single-handedly responsible for the exemption of over $363 million worth of property in Maine. As a matter of law, the exemption is provided to certain industrial facilities that are "installed, acquired, or placed in operation primarily for the purpose of reducing, controlling or eliminating" air or water pollution. Since 1993, the DEP has issued 145 separate certificates of property tax exemption with respect to property belonging to electrical utilities, paper companies, industrial agricultural operations, companies that handle and spread wastewater treatment plant sludge, computer chip manufacturers, and printing plants.

The original pollution control equipment exemption was enacted in 1961 and simply exempted "industrial disposal facilities" that produced no marketable by-product. In 1971, the exemption was modernized into its current form. The industries and the DEP say that the law is anachronistic. They say it needs to be stretched out to conform to the changes in environmental protection that have occurred since the early 70’s. Thirty years ago, they say, industries produced pollution and then bolted on equipment at the end of the pipe to treat the polluted water or air. Now, the approach to environmental protection is to reduce the creation of pollution within the production process. That may be, the municipalities say, but if some of the interpretations of the law now circulating are maintained, substantial amounts of industrial production equipment could become exempt at every industrial upgrade, along with a big chunk of the municipality’s tax base.

It might also be pointed out that virtually all of the pollution control equipment in dispute would qualify for the BETR reimbursement if installed after April 1, 1995, but to the extent the equipment is eligible for a tax exemption at the municipal level, it is ineligible for reimbursement under BETR.

The first specific municipal concern is that the standard of eligibility is so ambiguous that it has caused confusion at virtually every step in the process…at the DEP level (where the eligibility is certified), at the municipal level (where the exemption is realized), at the Board of Environmental Protection (where the certifications are appealed), and at the Superior and Law Court level. From the municipal perspective, the law requires the primary function of the exempt equipment to be pollution reduction. Some of the industries seeking exemption say that the law actually requires that the primary purpose of the installation to be pollution reduction, so what may otherwise appear to be normal production equipment could be eligible for exemption if the company is installing the new equipment with the intention (however that is measured) of reducing pollution.

The second issue of concern to municipalities is the quality of the DEP certifications. It would be more helpful to the municipalities if Maine Revenue Services ultimately issued the certification because MRS has an expertise in the assessing of industrial equipment that has not been readily apparent at DEP, at least in some instances.

The Tax Committee did not take the issue of pollution control equipment head on. Instead, the Committee is recommending the formation of a working group that will be charged with reviewing all the issues associated with the pollution control exemption and reporting its findings and recommendations back to the Taxation Committee, perhaps in time for action during this upcoming legislative session.

Financial Relief

The other element of the Taxation Committee’s recommendations is also not developed out in full detail, but it will entail a substantial relief mechanism that will give financial support to the municipalities that are supporting the institutional facilities providing services to large regions of the state or the whole state.

For the last several years, the Committee has been toying with the idea of a supplementary revenue sharing program that would distribute state revenues to municipalities in a more targeted way than the current system. Although some attempts have been made in recent years to amend the current revenue sharing system to distribute more of that revenue to high mill rate municipalities, the majority point of view on the Committee seems to be to leave the existing revenue sharing system in place and supplement it with a smaller, more-targeted system. The goal of Revenue Sharing II, as the supplementary system has been dubbed, would be to distribute funds to communities that have good assessing practices, high mill rates and play host to a disproportionate share of exempt institutions.

As a ball-park figure to describe the significance of the Committee’s recommendation, the sum of $20 million to be distributed in the program’s first year was adopted by the Committee, although there is a difference of opinion about whether that sum should be a straight appropriation year after year or be designed to come off the top of sales and income tax revenues, as is the case with traditional revenue sharing.

There are also numerous questions about the formula that would distribute this Revenue Sharing II, but the Committee purposefully held off on crafting the formula as of yet. At this stage the Committee felt is was more important to advance its findings to the full Legislature that this type of relief to the affected municipalities is necessary and warranted. The details on its distribution, and the effort that will be needed to see it through to enactment, can wait until the second session convenes in January.

There will be a public hearing on the Committee’s report and its set of recommendations, but the date of that hearing has not been set.

SIDEBAR:

Taxation Meeting

At the December 15th meeting, Taxation Committee members narrowly voted (6 to 5) in support of the package of tax exemption changes outlined in this article.

The committee unanimously supported the Revenue Sharing II concept. The approach favored would take .9% of sale/income tax revenue and distribute it based on the full value municipal tax rate.